Inflation ahead?

AGRICULTURE HASN'T been spared from the general economic turmoil that has gripped the world markets this year. And it's likely that the coming quarters won't be much brighter, with some sectors talking about the “I” word — inflation.

Although many economists aren't expecting inflation to affect the economy until it recovers, the growing federal deficit and a large money supply in the economy flash warning signs. Plus, a recent survey by Rabobank reports that less than 5% of farms saw incomes improve in 2009. A year earlier, 25% of the farms reported a better year-over-year income.

So what should growers do to prepare for the possibility of an inflationary period? Five experts advise farmers on how to weather the storm.

Lock in input costs early

In times of rapid inflation, it's a good idea to protect the cost side of the business. “So much will depend on the timing and the magnitude of what occurs in the economy,” Good says. “But if we're in an inflationary period, lock in input costs early. Conversely, be more patient on the output side. Commodity prices usually benefit from inflation.”

Ensure that your financial house is in order. “It's always a good strategy,” Good states. “And I think it's even more important with inflation. Even in the good years we continue to stress that saving is not a bad idea. Even without inflation, we are moving into a period with tighter margins that will put stress on the balance sheet.”

Land is a good bet

“The Federal Reserve has printed more money, so it is out in the economy,” Hayes says. “If we see the general economy start to recover, my hunch is that we will see some inflation. The exact timing as to when and how much is much less clear.”

Agriculture usually fares well during inflationary periods. “Investors look for things that hold value, and land and commodities are two things they move toward,” Hayes says.

But when will inflation move in? “In general, the things to look for as triggers are strong gold prices and a weak dollar, which is what we are seeing now,” he says.

What is needed is a general rebound in the economy that will increase overall spending. “The money out there now is not impacting the inflation rate,” Hayes says. If inflation starts to tick upward, growers should lock in long-term interest rates as far out as possible.

Hayes says that, if you are on the fence about buying land, the hint of inflation should tip you over to buying: “Land has been a good investment, because it has held its value.”

Secure long-term debt

“There is a tremendous amount of money being infused into the economy, and more is coming,” Frye says. “Much of the inflation question will depend on what the government does over the coming months. But I don't know how they can avoid inflation in the future.”

For growers, securing long-term debt should be a priority. “Fixed rates should be locked in,” Frye states. “While rates could potentially go lower, the overriding tendency will be for interest rates to creep higher. And the risk to your operation of higher long-term interest rates during an inflationary period is great.”

Making sure you have adequate cash on hand in the form of working capital has not been a priority in times of easy credit. But it will be if inflation comes into play. “If you have cash, you can rely on yourself for making decisions and not worry about securing short-term debt at a much higher interest rate,” Frye explains.

Land will remain a safe harbor, so consider holding it as a good hedge against inflation. Frye says, “Today's economic climate in agriculture is much different than the inflationary period of the 1970s” when the land boom depended on borrowed money. Today, land is much less leveraged. “Land over the past few years has been bought with large down payments, even in some cases fully paid for.”

Expect low commodity prices

What worries Ray is the price side of the agricultural economy. “I'm very cautious about the price future of corn and soybeans,” he says. “There's a general thought that we are at a new price level, but there's no reason to think that we can't have sub $2 corn at the farmer level if we have the right combination of supply-and-demand conditions. That's scary, because even at current prices producers are losing money.”

The ag sector has seen inflation in the form of higher input prices. The price squeeze could be even greater next year. “I worry as much about the revenue as the cost side of agriculture,” Ray says. “But I caution that we thought we were at a new price level back in the 1970s.”

What to do? “Look at expenses, and don't make expenditures with the expectation that prices will move higher,” Ray cautions. Prepare for the possibility that crop prices could be lower. Look for opportunities to secure land and other inputs well below what was paid in 2008. “I'd also watch the cash rents,” he says. “Don't be overly aggressive and try and outbid for land.”

Federal Reserve's actions

“The projected slow economic recovery and the U.S.'s GDP falling to a -2.5 to -3% in 2009 will make it difficult for strong price increases in the near term, while increased savings is also dampening demand,” FitzPatrick explains. “In 2010, food price inflation should return to the more normal level of about 2.5 to 3.5%.” That should decrease the possibility of inflation as the overall economy continues to operate at low capacity utilization rates.

The Federal Reserve's action also will have a major bearing on what happens on the inflation front. “The Fed is still working on an exit strategy,” FitzPatrick says. “If it doesn't act quickly enough when the economy turns, the large stimulus effect of looser monetary policy and quantitative easing over the past 18 months could see inflation rapidly emerge. The Obama administration's approach to fiscal policy will also be crucial for the same reasons.”

Commodity price inflation would be beneficial for growers. However, inflation in energy or agricultural input costs without corresponding increases in commodity prices will further damage margins. “Farmers can always best protect themselves by enhancing efficiency and productivity in their operation by removing costs and embracing technology and innovation,” FitzPatrick says.